Article author:Ray DalioArticle compiler：Block unicorn
The principle is as follows:
When a country has too much debt, lowering interest rates and devaluing the currency in which the debt is denominated are the most likely priority paths for government policymakers to take, so it pays to bet on that happening.
As I write this, we know that large deficits and significant increases in government debt and debt-servicing spending are projected in the future. (You can see this data in my writings, including my new book, How Nations Go Bankrupt: The Big Cycle; I also shared last week why I think the U.S. political system cannot control its debt problem.) We know that the cost of debt service (interest and principal payments) will grow rapidly, squeezing out other spending, and we also know that the odds that the increase in demand for debt will be matched by the supply of debt that needs to be sold are extremely low in the best-case scenario. I laid out in detail what I think all this means in How Nations Go Bankrupt, and described the mechanics behind my thinking. Others have stress-tested this, and there is now near-perfect agreement that the picture I paint is accurate. Of course, that doesn’t mean I can’t be wrong. You need to make your own judgment about what might be true. I’m simply offering my thinking for you to evaluate.
My Principles
As I explained, based on my experience and research over the past 50-plus years of investing, I have developed and documented certain principles that have helped me anticipate events so that I can bet successfully. I’m now at the stage in my life where I want to pass those principles on to others to help. Additionally, I think that to understand what is happening and what might happen, you need to understand how the mechanism works, so I have also tried to explain my understanding of the mechanism behind the principles. Here are a few additional principles and an explanation of how I think the mechanism works. I think the following principles are correct and helpful:
The most insidious and therefore most favored and most commonly used way for government policymakers to deal with the problem of excess debt is to lower the real interest rate and the real exchange rate.
While lowering interest rates and currency exchange rates in response to excess debt and its problems can provide short-term relief, it reduces the demand for money and debt and creates long-term problems because it reduces the return on holding money/debt, thereby reducing the value of debt as a store of wealth. Over time, this usually leads to more debt because lower real interest rates are stimulative, making the problem worse.
In summary, when there is too much debt, interest rates and currency exchange rates tend to be pushed down.
Is this good or bad for economic conditions?
Both are often good and popular in the short term, but harmful in the long term and lead to more serious problems. Lowering real interest rates and real currency exchange rates is…
…good in the short term because it is stimulative and tends to push up asset prices…
…but harmful in the medium and long term because: a) it gives people who hold those assets a lower real return (due to currency depreciation and lower yields), b) it leads to higher inflation, and c) it leads to greater debt.
Either way, this obviously does not prevent the painful consequences of overspending and being stuck in debt. Here’s how it works:
When interest rates fall, borrowers (debtors) benefit because it reduces the cost of debt repayment, making it cheaper to borrow and buy, which in turn pushes up investment asset prices and stimulates growth. That’s why in the short term, almost everyone is happy with lower interest rates.
But at the same time, these price increases mask the undesirable consequences of lowering interest rates to undesirably low levels, which is bad for both lenders and creditors. These are true because lowering interest rates (especially real interest rates), including by central banks pushing down bond yields, pushes up the prices of bonds and most other assets, which leads to lower future returns (for example, when interest rates go negative, bond prices rise). It also leads to more debt, which creates a bigger debt problem in the future. Therefore, lenders/creditors receive less return on the debt assets they hold, which leads to more debt.
Lower real interest rates also tend to reduce the real value of a currency because it makes the yield on money/credit lower relative to alternatives in other countries. This allows me to explain why lowering the exchange rate of a currency is the first and most common way for government policymakers to deal with debt excesses.
There are two reasons why a lower currency rate is favored by government policymakers and appears advantageous when explained to voters:
1) a lower currency rate makes domestic goods and services cheaper relative to those of countries whose currencies appreciate, thereby stimulating economic activity and driving up asset prices (especially in nominal terms), and…
2) …it makes it easier to pay down debt in a way that is more painful for foreigners who hold debt assets than for domestic citizens. This is because the alternative “hard money” approach requires tightening monetary and credit policy, which leads to high real interest rates, which in turn discourages spending and usually means painful service cuts and/or tax increases, as well as tighter loan terms that citizens are unwilling to accept. In contrast, as I will explain below, a lower currency rate is a “hidden” way of paying down debt because most people are not aware that their wealth is decreasing.
From the perspective of a depreciating currency, a lower currency rate also generally increases the value of foreign assets.
For example, if the dollar depreciates by 20%, U.S. investors can pay foreigners who hold dollar-denominated debt in a currency that is 20% less valuable (i.e., foreigners holding debt assets will suffer a 20% currency loss). Less obvious but real harm from a weaker currency is that holders of a weaker currency experience reduced purchasing power and borrowing capacity—less purchasing power because their currency has less purchasing power, and less borrowing capacity because buyers of debt assets are unwilling to buy debt assets (i.e., assets that promise to receive money) or the currency itself, which is denominated in a currency that is depreciating in value. It is less obvious because most people in countries with depreciating currencies (e.g., Americans who use dollars) will not see their purchasing power and wealth decline because they measure asset values in their own currencies, which creates the illusion of asset appreciation even though the value of the currency their assets are denominated in is falling. For example, if the dollar falls by 20%, U.S. investors will not directly see that they have lost .20% of their purchasing power on foreign goods and services if they only focus on the increase in the dollar value of their assets. However, it will be obvious and painful to foreigners who hold dollar-denominated debt. As they become more concerned about this, they will dump (sell) the currency and/or debt assets that the debt is denominated in, causing the currency and/or debt to weaken further.
In summary, looking at things only through the lens of one's own currency obviously creates a distorted perspective. For example, if the price of something (such as gold) increased by 20% in terms of dollars, we would think that the price of that thing increased, not that the value of the dollar decreased. The fact that most people hold this distorted perspective makes these ways of dealing with excessive debt "hidden" and more politically acceptable than other alternatives.
This way of looking at things has changed a lot over the years, especially from people being used to a gold standard monetary system to today's fiat/paper monetary system (i.e., money is no longer backed by gold or any hard asset, which became a reality after Nixon decoupled the dollar from gold in 1971). When money existed in paper form as a claim on gold (what we call a gold standard), people thought the value of paper would go up or down. Its value almost always went down, the only question was whether it went down faster than the interest rate earned on holding the fiat debt instrument. Now that the world has become accustomed to looking at prices through a fiat/paper lens, they have the opposite view - they think prices go up, not that the value of money goes down.
Because a) prices of things denominated in gold standard currencies and b) the amount of gold standard currencies, have historically been much more stable than a) prices of things denominated in fiat/paper currencies and b) the amount of prices denominated in fiat/paper currencies, I think looking at prices through the lens of a gold standard currency is probably the more accurate way to go. Apparently central banks hold similar views, as gold has become their second-largest currency (reserve asset) holdings, behind the dollar and ahead of the euro and yen, partly for these reasons and partly because of the lower risk of gold being confiscated.
How far fiat currencies and real interest rates fall, and how far non-fiat currencies (such as gold, Bitcoin, silver, etc.) rise, has historically (and logically should) depend on their relative supply and demand. For example, large debts that cannot be backed by hard currency can lead to large monetary and credit easing, which can lead to large declines in real interest rates and real currency exchange rates. The last major period when this happened was the stagflation period from 1971 to 1981, which led to huge changes in wealth, financial markets, economics, and political conditions. Based on the size of existing debts and deficits (not only in the United States, but also in other fiat currency countries), similar huge changes may occur in the next few years.
Whether this is true or not, the severity of the debt and budget problems seems unquestionable. In times like this, it is good to have hard currency. Gold has been hard currency to date, and for many centuries around the world. Recently, some cryptocurrencies have also been considered hard currency. For reasons I won't go into, I prefer gold, although I do hold some cryptocurrencies.
How much gold should one own?
While I am not here to give you specific investment advice, I will share some principles that help me form my perspective on this question. When considering how much gold to own versus bonds, I think about their relative supply and demand and the relative costs and rewards of owning them. For example, with U.S. Treasury bonds currently paying about 4.5% and gold paying 0%, it would be logical to own gold if I believed that gold would rise by more than 4.5% over the next year, and it would be irrational if I did not believe that gold would rise by 4.5%. To help me make this assessment, I look at the supply and demand for each.
I also know that gold and bonds can diversify risk with each other, so I consider how much of each should be held for good risk control. I know that holding about 15% in gold can effectively diversify risk because it provides a better return/risk ratio for the portfolio. Inflation-linked bonds have the same effect, so it's worth considering adding both assets to a typical portfolio.
I share this with you, not to tell you how I think the market will move, or to suggest how many assets you should own, because my goal is to teach a man how to fish, not to give him a fish.
Brian
Joy
Kikyo
Alex
Hui Xin